Practical Application: Preparing Basic Income & Retained Earnings Statements in Accounting

Instructor: Scott Tuning

Scott has been a faculty member in higher education for over 10 years. He holds an MBA in Management, an MA in counseling, and an M.Div. in Academic Biblical Studies.

The income statement and retained earnings statement represent two of the four foundational financial reporting documents. Nearly every accounting professional will prepare these documents - this scenario will allow you to practice for a fictional company.

Two Important Accounting Documents

In nearly every organization, there are four major financial statements that must be prepared regularly. Two of those are the income statement and the retained earnings statement.

Although they are similar, they have an important difference.

  • The income statement, sometimes also called a profit and loss statement, outlines an organization's income and expenses in a reporting period (month, year, etc.).
  • In contrast, the retained earnings statement is focused on reporting the accumulation of profit over time. Both documents play a pivotal role for all of the organization's internal and external stakeholders.

If you need a bit more detail than the overview above, you can review the lesson titled Preparing the Basic Income Statement and Statement of Retained Earnings.

Now let's check out a scenario to practice generating these documents for a fictional company.

Scenario: Changing the Pricing Structure

Jackie has been the bookkeeper and accountant at her father's industrial supply store called Aardvark Contractor's Supply, LLC . In business now for nearly 30 years, Jackie's father grew the company from a sole proprietorship with no employees to a solid small business that now employs more than 45 people.

Unfortunately, economic conditions have made it harder and harder to keep up financially. Jackie knows that the present state isn't sustainable, so she's carefully evaluating the company's financials as she looks to maximize revenue and curb spending.

  • For Jackie's specific goal, is the income statement or the retained earnings statement the more important of the two? Why?
  • Does she truly need both of these documents, or can her questions be accurately answered with just one? Why?

In actuality, both documents are equally important, and Jackie will absolutely need both in order to make wise, informed decisions.

The retained earnings statement will help Jackie identify a time when the business was very profitable, and it will help her understand the trends associated with profitability. The income statement will help her determine how the business is making and spending money. She'll use this data to determine whether every dollar spent is effectively bringing in revenue.

The Raw Data

Jackie won't be able to create either of the two financial statements without having all the appropriate raw data at her finger tips. In a few minutes, you'll prepare the retained earnings statement and the income statement just as Jackie would. Before you do that, you'll want to organize the data below. Right now, it's in a random, disorganized state.

Raw Data

  • Using the raw data above, create an accurate and properly formatted income statement (for the year 2017) and retained earnings statement. Then compare your statements to the ones below and see if you captured everything correctly.

The Income Statement for 2017

Formatted Income Statement

  • Now that you've created the income statement, interpret the key points contained therein.

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